THE SAVING-INVESTMENT PROCESS IN A THEORY OF FINANCE*

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THIS STUDY ANALYZES the saving-investment process in a theory of finance. In so doing, it leans heavily on the writings of Gurley and Shaw, Hicks, Keynes, and Lavington. The saving-investment process is shown to be affected by various costs of financeboth real and monetary. Finance costs are generally ignored-either implicitly or explicitly-in neoclassical macroeconomic models. A macroeconomic model of the saving-investment process incorporating finance costs is presented. The finance costs facing savers and investors are shown to include both transaction costs and the costs of bearing risk. The nature of each of these costs, together with ways in which they may be minimized, is examined for both savers and investors. Innovations in finance are shown to reduce the finance costs facing savers and investors. Hence, financial innovations affect the levels of both saving and investment. Two types of financial innovations are distinguished: innovations in direct finance and innovations in indirect finance, or financial intermediation. Evidence concerning the development of finance in the United States is set forth. Special emphasis is placed on the growth of financial intermediaries and of two factors affecting their rate of growth-namely, the introduction of new types of financial intermediaries and the enhancement of the efficiency of certain existing ones. The growth of financial intermediaries is studied in terms of both national aggregates and intermediary, types. The assets of all financial intermediaries have grown significantly during the past one and one-half centuries, both in absolute terms and in relation to total, or national, assets. The rate of growth is shown to have slackened during the post-World War II period. Several hypotheses which could account for this decline in the intermediaries'. rate of growth are considered. Study of the individual types of financial intermediaries reveals a relative decline of commercial banks' assets. The nature of this decline is discussed in detail. Examination of organizational innovations in financial intermediation reveals that the most profitable types of financial intermediaries were the first to be established. These types have succeeded in avoiding obsolescence over nearly two centuries. Examination of the operational efficiency of certain existing intermediaries-mutual savings banks, member savings and loan associations, federal credit unions, and insured commercial banks-is beset by a number of problems: the brevity of the period for which data are available, conceptual problems in the calculation of the relevant data, and the imperfect disaggregation of the data. Despite these problems, the evidence does suggest that the operational efficiency of mutual savings banks, member savings and loan associations, and federal credit unions has been enhanced. Of these intermediaries, the enhancement of efficiency appears to have been greatest for the member savings and loan associations.